June 26, 2009

Economic predictions

Economists are frequently called upon to make forecasts about the path of the economy. Can you briefly tell us how such projections are made and whether there are any inherent problems in the forecasting methods?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, like those people in our sister profession - meteorologists - what we as economists do is, we build models. We simplify the economy. We try to calibrate those models using past data, past circumstances, and then we use those results to say what the future is going to look like. That is to say, if we saw something that is occurring now that happened in the past, then we can look at what subsequently occurred, and we can, perhaps, take that and say, this is what we think will happen down the road right now. Now, all that is based, of course, number one, on the model's being accurate and number two, having data in the past that does reflect what we're seeing now. And this is where we've had a big problem with this recession. The collapse of the housing market - the record drop in housing prices, the record drop in housing sales - we have never seen that. Economists never saw that in the past, even in the 1930s. So one reason why economists' predictions about this recession have been relatively bad is because we didn't see this kind of occurrence in the past. We didn't see the collapse of the housing market. So this is why it makes predicting the economy - particularly when we're seeing the kind of economy now that we've had recently - very, very difficult."